Wild swings too hot for traders who chase volatility
CHICAGO (Reuters) - Traders who have thrived on wild swings in market prices for decades are now having trouble staying on the unprecedented rollercoaster that is Wall Street.
The jerky swings in the Dow Jones industrial average .DJI has been compounded by the lack of liquidity, brought on by hedge funds which are being forced to reduce leveraged positions.
"The crash of 1987 was a picnic compared to what traders are seeing today," said Steve Claussen, chief investment strategist for online brokerage OptionsHouse, a subsidiary of options trading firm PEAK6 Investments LP in Chicago.
TrimTabs Investment Research estimated that investors yanked at least $43 billion from hedge funds in September, reacting to their poor performance.
Hedge funds are not alone to blame for the volatility.
The credit markets, the lifeblood of economic growth, remain frozen and investors still doubt actions by the Federal Reserve and other world central banks will stave off a deep recession.
"As unfortunate as it is, this kind of volatility is 'natural' during a market crisis," said Joe Sunderman, senior market analyst at Ohio-based Schaeffer's Investment Research.
On Wednesday, the Dow industrials dropped 733 points in the biggest percentage decline since the crash of '87. On Thursday, the Dow closed up 400 points to end at 8979.26.
All together, in eight out of the first 12 trading days in October, the range of the Dow industrials has been greater than 500 points.
"I have never seen a market move like this!" said Claussen, who has been a trader in stocks, futures and options for the past 25 years.
REDEMPTION AVALANCHE
An avalanche of redemption requests not only from hedge funds but mutual funds has also contributed to the volatility.
Frederic Ruffy, options strategist at New York-based Web site WhatsTrading.com, said many investors are now getting their quarterly statements from brokers and mutual fund companies -- and are liquidating shares. "Big losses is not what they signed up for," he said.
In 2008, the Dow has lost 32 percent while the Standard & Poor's 500 .SPX has suffered a 36 percent drop.
Mutual funds typically receive Net Asset Value as calculated by the market close.
"Therefore a mutual fund company who has to sell holdings to raise cash to deliver to a redeeming customer needs to sell as close to the market close to match up with the mechanics of delivering NAV to the customer," Claussen said.
The overall uncertainty about the future direction of stocks as well as the economy is being reflected in Wall Street's so-called fear gauge which surged to an unprecedented reading of 81.17 Thursday morning.
The Chicago Board Options Exchange Volatility Index .VIX has come off that lofty level but still remains elevated, indicating investors remain as fearful as ever.
"Basic uncertainty creates volatility and little things get magnified into more dramatic moves," said Douglas Engmann, president of Engmann Options, a proprietary options trading firm in San Francisco.
"At the end of the day traders like to have no positions. So they cover their shorts in an up market and they sell their longs in a down market. So you see these exacerbated moves in the last hour."
(Reporting by Doris Frankel)
